Israel’s Economic Challenges Require Structural Reform

Israel is engaged in an ongoing war and thus faces many challenges. The macroeconomic and budgetary realities of 2025 and onwards may very well be different from what was forecast before the war, even assuming a complete victory restoring security to the North and South of the country. There are four major reasons for this:

• The increase in interest payments following the rise in debt-to-GDP ratio due to the large deficits of 2023 and 2024 (resulting from the sharp rise in defense and social welfare spending and the loss of tax revenue due to the slowdown in economic activity);
• The anticipated increase in defense spending in the years to come, relative to former projections;
• The increase in interest payments following the rise in anticipated risk premiums required by investors (on the grounds of war, debt increase, and the rise in defense spending);
• The anticipated reduction in growth rates relative to former projections (due to the rise in risk premiums and defense spending).

Under these circumstances, it is vital to implement economic policies that, within a few years, ensure the restoration of the fiscal buffer that protects the Israeli economy from various shocks to what it was before the war. Succeeding at this will also make it possible to reduce risk premiums, debt-to-GDP ratio, and the burden of interest payments; to signal macroeconomic stability and policy credibility; and to significantly improve the degree of the overall national sense of security, the economy’s growth potential and the general public’s welfare.

Such policies must be centered on three primary components:

• Incrementally closing the gap between the projected deficit and the former deficit target (1.5% of GDP). To guarantee this, the government must take significant budgetary steps in the coming years to reduce government spending and expand the tax base by canceling tax benefits (but not by raising tax rates).
• Taking steps to start the process of budget alignment as early as this year, in the amount of ten billion shekels. This is vital to prevent sharp cuts in the future, to project seriousness and stability, and to minimize risk (there is no guarantee that further negative shocks will not occur in 2025 or later). The remaining necessary steps (amounting, according to various estimates, to approximately twenty to forty billion shekels) can be delayed to the next years, but it would be advisable to give declarations of intent now and to likewise begin the process for the necessary legislation.
• Implementing structural reforms and altering priorities in a way that leads to improving the growth potential of the economy, despite likely unpopularity or resistance by specific sectors of the Israeli economy or society. Before the war, the government allowed itself policies that “sacrificed” future growth for current political-party-sectorial demands. Today, post-October 7, the price of such luxuries is simply too high.